Treasury’s Tapering Seen Outpacing Fed, With $1 Trillion in Cuts
(Bloomberg) -- The Federal Reserve won’t be the only one announcing a taper on Wednesday. The Treasury Department, for the first time in more than five years, will likely unveil a scaling down of its behemoth quarterly sale of longer-term securities.
In time, the Treasury’s reduction in issuance of coupon-bearing debt -- notes and bonds with interest payments -- will outweigh the Fed’s zeroing out of its quantitative-easing purchases of Treasuries. It’s a dynamic that hasn’t captured sufficient attention from investors, according to Wells Fargo & Co., and could help limit increases in borrowing costs as the central bank withdraws stimulus.
Sales of regular coupon-bearing debt will be pared back by some $1 trillion by about the third quarter of 2022, according to a number of Wall Street banks. By comparison, Fed Chair Jerome Powell has said the central bank’s $80 billion-a-month in Treasuries purchases will be completely terminated by mid-2022.
The reductions are expected to start with auctions at the so-called quarterly refunding next week, which is forecast to total less than the record $126 billion of the past three episodes.
While the Treasury’s exact borrowing needs will depend in part on two longer-term fiscal packages that Congress aims to enact in coming weeks, the U.S. budget deficit is now on a downward path -- making the record auction sizes put in place last year to fund pandemic relief unnecessary.
“Under a relatively wide range of plausible outcomes for the fiscal packages being negotiated, the current auction schedule will result in substantial over-funding for Treasury,” said Praveen Korapaty, chief rates strategist at Goldman Sachs Group Inc. “And these issuance reductions will largely offset the expected loss of demand from the Fed as it tapers asset purchases.”
The Treasury’s Wednesday release, coming just hours before the Fed’s policy announcement, will cover details of the department’s November quarterly refunding sales. Those include 3-, 10- and 30-year debt, as well as plans for any changes in Treasuries issuance over the coming months.
Primary dealers’ expectations for the auctions center around $119 billion to $120 billion in total.
Issuance plans are expected to assume that Congress will lift the federal debt ceiling, which on the basis of currently legislated limits is likely to prevent further borrowing at some point, from as soon as early December. Treasury Secretary Janet Yellen said Democrats should be open to acting on their own to address the debt ceiling, the Washington Post reported.
“Once again, Treasury is faced with making financing projections with uncertainty over government spending,” Jefferies analysts Thomas Simons and Aneta Markowska wrote in a note. They referred to the outstanding need to boost the debt limit and the lack of clarity about any potential deficit financing tied to a $1.75 trillion social-spending bill Democrats are trying to pass.
Still, dealers generally expect the Treasury to follow the advice of its borrowing committee -- a group comprising dealers, investors and other stakeholders -- which recommended in August reductions to all maturities starting in November, with heavier cuts for 7- and 20-year Treasuries.
TBAC Suggests Cutting Nominal Coupon Auction Sizes in November
The Jefferies team expects the following:
- Refunding sales totaling $118 billion
- Reductions across maturities:
- $2 billion per month for 2-, 3-, and 5-year notes
- $3 billion per month for 7-year notes
- $3 billion for 10- and 30-year new issues and reopenings
- $4 billion for 20-year bond new issues and reopenings
With the world’s biggest debt market on the cusp of a major shift in the supply-demand dynamic -- and some differences of opinions by dealers on how much each tenor is cut -- it may provide some trading opportunities for investors.
Inflation-linked debt is the one category dealers foresee Treasury continuing to increase issuance. That’s as increases of Treasury Inflation-Protected Securities trailed the pace of the boost to regular, or nominal, notes and bonds over the past year and a half. Inflationary fears also have been stoking demand for TIPS.
What remains a wild card for issuance plans is the Treasury’s desire to rebuild an ample cash buffer, after it was forced to run down its stockpile thanks to the debt-limit strains of recent months. To do that, it will need to ramp up the supply of Treasury bills.
The Treasury’s cash balance is about $260 billion now, having rebounded since it plunged to $47 billion on Oct. 14 -- its lowest since September 2017.
“Bill issuance levels are very hard to pinpoint with certainty now because it’s really dependent on how fast Treasury runs out of cash and how fast the debt ceiling gets resolved,” said Jan Nevruzi, a strategist at NatWest Markets.
NatWest’s base case is that the debt ceiling will be resolved in November or early December. That, the firm predicts, will enable the Treasury to lift net bill issuance in 2022 by about $300 billion -- bringing its cash balance back to around $800 billion.
Still, most investors will be more keenly focused on the likely inflection point of falling Treasury note and bond issuance and the potential for that dynamic to help limit any increase in borrowing costs as the Fed normalizes policy.
“We expect Treasury supply will fall faster than the Fed’s Treasury purchases,” a team of Wells Fargo strategists including Zachary Griffiths said in a note. And “reduced Treasury supply has been receiving too little attention in the market. This should change on November 3, with the Treasury refunding to resemble a slasher movie a couple of days after Halloween,” they wrote.
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